What is EPS (earnings per share) in the stock market?

The full form of EPS is Earning per Share. It is a popular metric for determining business value. It is defined as the value of earnings per outstanding share of the company’s common stock.

EPS measures a company’s profitability by displaying how much money it makes for each share of stock it owns. Divide the company’s net profit by the number of outstanding shares of common stock to get the EPS value.

However, the higher the EPS value, the more profitable the corporation is thought to be.

EPS Formula

Earnings per share are computed by dividing the net income of the company by the total number of outstanding shares. In general, they are calculated in two ways:

1. Earnings per share are calculated as: Net Income after Tax/ total number of outstanding
2. Earnings per share: (Net Income after Taxes – total dividends)/total number of outstanding shares

For example, suppose a company, XYZ, has a net income of Rs. 14 lakh, must pay Rs. 2 lakh in preferred dividends, and has Rs. 4 lakh common shares outstanding (weighted average) in the current period.

As a result, according to the earnings per share (EPS) calculation, XYZ Company’s EPS would be –

= Rs. (14,00,000 – 2,00,000)/ 4,00,000

= Rs. 3 per share

EPS is typically calculated using the company’s balance sheet and income statement. Furthermore, because the number of shares may vary over time, it is frequently advisable to choose the weighted average number of common shares.

Notably, dividends generated on both cumulative and non-cumulative preferred stocks have a varied impact on the final EPS.

For example, to calculate current EPS, deduct the dividends on cumulative preferred stocks for the current period from the net income. Even if no dividend is declared in a particular year, the procedure is followed. Dividends, on the other hand, are normally not deducted from the current year’s net profits unless declared by management.

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Types of Earning of Shares

EPS comes in a variety of forms, each of which represents a particular facet of this financial metric. It is because, based on EPS, a company’s stock appears to be cheap or overvalued. There are 5 types of earning per share-

1.  Continuous EPS or Pro Forma EPS

This variation, also known as the Pro forma EPS, is based on ordinary net income and tends to omit anything that can be usually passed off as an unexpected one-time event. Typically, it aids in determining predicted income from key business activities but does not aid in projecting a record that shows the company’s true earnings.

Notably, the term proforma denotes that some assumptions were made throughout the computation. For example, certain income or expenses used to calculate reported earnings are not included in this EPS fluctuation.

2.  GAAP EPS or reported EPS

This deviation is achieved by the use of Generally Accepted Accounting Principles and is stated in SEC filings. However, GAAP can affect a company’s earnings. To elaborate, if the income earned by the one-time sale of machinery is recognised as operating income under GAAP, it has the potential to boost EPS. Similarly, if businesses opt to categorise major routine expenses as unusual expenses, it will artificially inflate earnings per share.

3.  Retained EPS

It denotes the amount of profit that a corporation decides to keep rather than distribute to its shareholders as dividends. Business owners can choose to use their retained earnings to pay off existing debts, expand their operations, or keep them as a reserve for future needs.

The retained earnings per share are calculated by adding net earnings to current retained earnings and then deducting the entire dividend paid from that total. Finally, the balance is divided by the total number of shares outstanding.

As a result, this formula is used to calculate the retained EPS – Retained EPS = (Net earnings + current retained earnings) – divided paid/total number of outstanding shares

4.  Cash EPS

It is one of the most important EPS variations since it provides a better understanding of a company’s financial situation. This is due to the fact that the Cash EPS represents the precise amount of money earned. Furthermore, unlike net income, this change in earnings per share is harder to manage.

Further, it can be stated as

Cash EPS = Operating Cash Flow/Diluted Shares Outstanding

Importance of EPS

The following points demonstrate the significance of earnings per share in determining a company’s profitability and financial status –

• It determines whether investment in a company will help investors earn higher To elaborate, higher EPS signifies a profitable position, which means that the dividend distribution may be increased over time.
• EPS not only serves to gauge a company’s present financial position, but it also helps to track its past success. A company with a steadily increasing EPS, for example, is frequently regarded as a safe investment Similarly, companies with fluctuating or inconsistent earnings per share are normally avoided by seasoned investors.
• Also, Helps in comparing the performance of promising companies in order to select the best investment

Limitations of EPS

Although earnings per share is regarded as a powerful financial tool, investors should keep in mind that it has some limitations.

Most business owners frequently alter the EPS to portray their venture as prosperous. However, the majority of such initiatives are undertaken for the short term, which frequently harms a business’s image and profits in the long run.

Because EPS does not account for inflation, the growth it indicates may be inaccurate in the first place. Inflation, for example, raises the overall price of goods and services. As a result, if the company fails to purchase or sell more things than it did a year before, the EPS value will be misleading.

As a result, before deciding on a company as an investment choice, investors should consider other essential factors. In reality, they should combine Earnings per Share with other financial metrics to get a good sense of a company’s total scope, profitability, and market success.

 

About the Author

Ketan Sonalkar (SEBI Rgn No INA000011255)

Ketan Sonalkar is a certified SEBI registered investment advisor and head of research at Univest. He is one of the finest financial trainers, with a track record of having trained more than 2000 people in offline and online models. He serves as a consultant advisor to leading fintech and financial data firms. He has over 15 years of working experience in the finance field. He runs Advisory Services for Direct Equities and Personal Finance Transformation.

Note – This channel is for educational and training purpose only & any stock mentioned here should not be taken as a tip/recommendation/advice

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